These are positive statistics and why we believe it is prudent to separate the precious metals component from broad based indexes, both strategically and tactically.

Factors

These are four major factors cited recently by the World Gold Council that lend support to the investment case for gold.

Inflation risk

Medium-term tail-risk from imbalances

Currency debasement and uncertainty

Low real rates and emerging market real rate differentials

Zenith’s commentary on each factor

1. Inflation risk-While there is much debate on the true dynamics of inflation, there has not been a massive upsurge in traditionally defined inflation (CPI). This is in spite of a massive quantitative easing campaign by the world’s central banks. In part this is due to the continued decline in the velocity of money in the economy. At least in the US, bank lending is still very slow and in Europe the economy is anemic at best.

Also, it is important to note that gold has not always been correlated with inflation over certain periods of time.

2. The massive imbalances across sovereign balance sheets globally is worrisome especially as countries attempt to balance growth and austerity. Also, credit buildup in risk assets is fostered in large part by artificially low interest rates. While temporarily beneficial, most credit imbalances correct themselves and gold may hedge this risk.

3. The “race to the bottom” continues as monetary authorities continue expansionary monetary policy. Japan’s latest attempt to break free of deflationary forces is just one of many examples of forced currency devaluation.

4. Low real interest rates have been a positive factor for gold. While this should continue, a surge in inflation may prompt central banks to tighten earlier than expected possibly increasing real interest rates depending on the degree of tightening.

Gold holdings for sovereigns as of Sept 2012

Country

Tons of Gold held in reserves

% of foreign reserves held as gold

US

8133

77.7%

Germany

3396

74%

Italy

2451

70.9%

France

2435

73%

China

1054

2%

Statistics are taken from the IMF and presented by the World Gold Council. While updated in September, there may be numbers that are a couple months old.

We feel that China will continue to purchase gold in order to diversify it’s reserves. At 2%, it has a long way to go in order to approach many developed countries percentages or to even produce a reasonable hedge against its paper assets.

Third quarter 2012 gold demand statistics

Source of Demand

% change in demand in Q3 ’12 from Q3 ’11

Jewelry Demand

-2%

Technology

-6%

Investment

-16%

Official Sector

-31%

Third quarter demand was up 10% compared to the second quarter but 11% less than the 3rd quarter a year earlier. The %s in the table are weighted and given the underlying weightings represent an average of -11% decline.

This is not as significant as it appears as 2011 was a record year in many respects for gold purchases. Jewelry demand will ebb and flow mainly with the Indian and Chinese economies while investment demand is partly dependent on a large investor block continuing to believe in inflation potential and central bank balance sheet expansion.

Bear case

Dollar strength-Gold and the $ have traditionally been negatively correlated. The flight to safety and out of European denominated assets has given the dollar a strong boost. As attention may turn to our own fiscal issues, the dollar may not continue appreciating. Also, even if it holds at these levels, there could be a case that institutions that are overweight dollars, may seek to diversify into gold.

Emerging market weakness continues-Consumers in India and China are unable to consistently buy gold if their economy slows.

Deflation-Since gold is perceived as only an inflation hedge by some investors, a global inflation slowdown with deflation could place pressure on this metal.

Bull Case

Deflationary concerns in some countries provide room for further fiscal and monetary stimulus. This may lead to a further debasement of currencies through unconventional monetary policy.

The underlying structural issues that affect the euro zone remain unresolved, despite advances in the formation of more comprehensive burden-sharing mechanisms. In such an environment of uncertainty and higher market volatility, gold will continue to be an asset that investors use to diversify risk and preserve capital.

We recommend that investment committees examine each factor that supports the case for gold. Determine the factors prevalence going forward and the risk to each one. A full examination would include historical and current correlation trends as well as a closer look at each segment of demand.